NCPA - National Center for Policy Analysis

Does The Tax Code Influence CEO Compensation

March 7, 2001

In 1993 Congress enacted legislation to limit the corporate tax deductibility of executive pay, capping the deduction for the corporation's top 5 executives to $1 million per person. A study based on data from 1,400 publicly-traded U.S. corporations shows that this legislation had no significant effect on overall executive compensation levels because of two loopholes.

  • First, the limit only applies to the top five executives employed as of the end of the fiscal year, creating the opportunity for compensation to occur as part of a post-retirement package.
  • Secondly, there is an exemption for "qualified performance-based compensation", thereby allowing compensation in excess of $1 million if it is linked to objective measures of performance and is administered by outside directors on the board.
  • Nearly 75 percent of firms studied were able to qualify a portion of their compensation packages for this exemption.

The effect of this legislation was to slow salary growth and kept top executive's salaries around the $1 million range, but it had little effect on bonus payments, stock option awards, and long-term incentive pay.

Source: Lucille Maistros, "Does the Tax Code Influence CEO Compensation," NBER Digest, December 2000; based on Nancy Rose and Catherine Wolfram, "Regulating Executive Pay: Using the Tax Code to Influence CEO Compensation" NBER Working Paper No. 7842, August 2000, National Bureau of Economic Research, 1050 Massachusetts Avenue, Cambridge, Mass. 02138.

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